California Changes Combined Reporting for Assignment of Combined Group Sales

On May 26, 2011, California’s
Franchise Tax Board (FTB) held an interested parties
meeting to discuss possible amendments to the
regulations pertaining to the assignment of sales of
tangible personal property by members of a combined
reporting group. The focus of the discussion was on CA
Code Regs. Title 18, Section §25106.5(c)(7)(B)3, which
adopted the Joyce rule in 2000.
However, in 2009, the California legislature adopted
the Finnigan/Nutra-Sweet
rule, requiring revision of the existing regulations
(CA Rev. and Tax. Code §25135).

For tax years
before January 1, 2011, receipts from sales of
tangible personal property by a combined reporting
group were assignable to California as long as the
member generating the sale was taxable in the state.
Thus, for purposes of the sales factor of California’s
apportionment formula, California sales (i.e., the
numerator) included only those sales shipped to a
purchaser in the state by members of the combined
group with nexus in the state. As stated in the
regulation, “if a member of the combined reporting
group sells goods shipped to a purchaser in
California, and that member is not taxable in
[California], the sale is not assigned to California,
even if another member of the combined reporting group
is taxable in [California].” Joyce had also
provided a throwback provision whereby sales of
tangible personal property to a state other than
California were thrown back to California if the goods
were shipped from the state and the member was not
taxable in the destination state (Appeal of Joyce,
Inc., No. 66-SBE-070 (Cal. State Bd. of
Equalization 11/23/66)).

For tax years
beginning on or after January 1, 2011, California has
adopted the Finnigan/NutraSweet
rule, which requires that receipts from the sale of
tangible personal property of all members of the
combined reporting group be assigned (i.e., sourced)
to California, regardless of whether a specific member
has nexus in the state. Thus, even if a member entity
is not taxable in California, all sales appropriately
assignable to California must be included in the sales
factor numerator.

It is important to note that
the inclusion of sales of the nontaxable member does
not necessarily mean that an entity without nexus in
the state will be subject to tax. The Finnigan rule,
which has been upheld by the California Court of
Appeals (Citicorp
North America, Inc. v. Franchise Tax Board,
100 Cal. Rptr. 2d 509 (Cal. Ct. App. 2000), cert. denied, Sup.
Ct. Dkt. No. 00-1537 (6/29/01)), is merely a method of
calculating how much income is properly attributable
to the business activities of the combined reporting
group in the state. With the adoption of Finnigan,
California eliminated its throwback rule (Appeal of Finnigan
Corp., No. 88-SBE022-A (Cal. State Bd. of
Equalization 1/24/90)). As long as any member of the
combined reporting group is taxable in another state,
receipts from the sale of tangible personal property
will not be thrown back to California, regardless of
whether the sale was generated by a member not taxable
in that other state.

As of this writing, the
FTB has not finalized the Finnigan
regulations. However, based on a consensus of the
interested parties, the FTB will use the language from
a 2000 version of the draft regulation as a starting
point. A final draft of the regulation is not expected
until after publication of the 2011 tax forms;
however, the revised regulation will be made
retroactive, if necessary.

EditorNotes

Mark Cook is a partner at SingerLewak LLP in
Irvine, CA.

The editor would like to offer a
special thanks to Christian J. Burgos, J.D., LL.M.,
for his assistance with this column.

For additional information about these items,
contact Mr. Cook at (949) 261-8600, ext. 2143, or mcook@singerlewak.com.

Unless otherwise noted,
contributors are members of or associated with
SingerLewak LLP.

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